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Module1

Cost Accounting: Information for Decision

Making

Learning objectives:
After completing this module, you should be able to:
1. Describe the role of cost accounting information in value creation.
2. Explain how cost accounting information is used for decision making and
performance evaluation in organizations.
3. Identify trends of cost accounting throughout the value chain.

As an entrepreneur, you must have a basic understanding of accounting as to

accounting plays a big role in the success of your business. Accounting is said to be the
“Language of Business.” Like how a doctor diagnose its patient through various laboratory
test in order to give him a cure, it is through accounting that an entrepreneur can recognize
the condition of its business in order to provide appropriate decisions to prevent the
business from bankruptcy. The primary objective of accounting is to provide information
that is useful for decision-making purposes.

With that, hopefully you will be able to appreciate this subject and learn from it.

Let us start with quotes from famous entrepreneurs. What do you understand from
the quotes? Do you agree or disagree?

a. “Don’t think of cost. Think of value.” – John Spence

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b. “Cost is more important than quality but quality is the best way to reduce cost.”
– Genichi Taguchi
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Being the responsible student that you are, do some advance reading on cost
accounting in order to be familiarized with the different technical terms. As you go through
your readings, make a handwritten memory aid. A memory aid is a tool or a cue sheet
containing relevant information used for purposes of recall. Make this a part of your study
habits as this will help you in the future.

Value Creation in Organizations

In order to understand the role of cost accounting, let us first go through value
creation in organizations. Because value creation is the starting point for all businesses, it’s
a fundamental concept to understand. It is the purpose of the organization to create and
deliver value in an efficient enough way that it will generate profit after cost.

So, how is value created? In the broadest terms possible, value is created through
work. This work could be mechanical such as harvesting bananas and turning it into banana
chips or creative which includes creating a logo or writing a paper. Of course, not all work
is value-creating like counting the chips before packing and later on weighing it removing
the chips added in excess of the required weight per pack.

As there are different possible ways to create value, how do we decide which type
to pursue? Is each way of creating value as useful as another? As we go further with the
lessons, we will be able to answer this questions.

Accounting systems
An accounting system consists of the personnel, procedures, technology, and
records used by an organization to keep track of all types of financial transactions, including
purchases, sales, liabilities, etc. to develop accounting information and to communicate
these information to management or interested parties to aid in the decision-making
process.
In order to satisfy its purpose, the design and capabilities of these systems vary from
one organization to another. For example, accounting systems for manufacturers should
have information on inventory, labor hours, overhead expenses and sales commissions. A
manufacturer can have three types of inventory: raw materials, products in production and
finished products. A manufacturer also needs to know how many man-hours are used to
make each product.

On the other hand, accounting systems for retailers shall contain a detailed reporting
of inventory. These details should include the level of inventory, the annual turnover rate,
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and the profit of each product and its reorder points. Since most retailers buy many different
products, their accounting system needs extensive information on the delivery times and
available discounts.

Accounting system within an organization has two major subsystems: a financial

accounting system and a management accounting system. The table below provides for the
differences between the two.

Source: https://qph.fs.quoracdn.net/main-qimg-43781147cacd94997457058607bbe8e3
Cost accounting is a hybrid of financial and management accounting. It is defined
as the system that records, summarizes, analyzes and interprets the details of the costs of a
manufactured product or a service. Through cost accounting, management is informed of
those operating functions that fail to contribute their share to the total profit or that perform
inefficiently, leading to profit erosion.

Cost data for managerial decisions

To study cost accounting, it is necessary to understand what cost is. Cost is defined
as the measurement, in monetary terms, of the amount of resources used for the purpose of
production of goods or rendering services. Costs are classified as follows:

I. Costs to Make and Sell

A. Manufacturing or Factory or Production Cost – it is the sum of the cost of Direct
materials, Direct labor, and Factory overhead. Note that during the accounting
period, the part of factory cost which represents work completed is transferred to
Finished Goods while incomplete work remains in Work in Progress.
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B. Operating or Commercial Expenses

1. Selling expenses – cover the expenses of making sales and delivering products
that starts at the point where the factory costs end. Examples are salaries of sales
personnel, shipping fees, and advertising fees.
2. General expenses – include all costs associated with the general administration
of the organization that cannot be reasonably assigned to either marketing or
production. Examples are research and development, general accounting fees
and costs of printing annual reports.

II. Costs in Relation to the Product

A. Direct Material – all materials that form an integral part of the finished product and
that can be included directly in computing the cost of the product.
B. Direct Labor – labor expended directly upon the materials comprising the finished
product.
C. Factory or Manufacturing Overhead – all production costs other than direct material
and direct labor. This includes the indirect materials, indirect labor, and all other
indirect manufacturing costs.

III. Costs in Relation to Volume of Activity

A. Fixed Costs – costs that tend to remain constant in total amount within the relevant
range even if the volume of activity changes.
B. Variable Costs – costs that tend to change in total amount in direct proportion to
volume of activity but is constant in cost per unit in the face of changing volume.
C. Mixed Costs – costs that vary with output but not in direct proportion to the volume.

IV. Costs in Relation to Manufacturing Departments

A. Producing department is one whose costs may be charged to the product because
they have contributed directly to its production
B. Service department is one that is not directly engaged in production but renders a
particular type of service for the benefit of other departments

V. Costs in Relation to Analyses for Decision Making

A. Relevant and Irrelevant Costs
1. Relevant costs – costs that could be influenced by decision making, these are
future costs and are different between decision alternatives.
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2. Irrelevant costs – costs that could not be changed by decision.

B. Differential Costs – refers to the difference between any two alternative courses of
action.
C. Avoidable Costs – costs that can be eliminated by virtue of an alternative.
D. Postponable Costs – costs that may be deferred or shifted to a future date or period
of time without adversely affecting current operations.
E. Out-of-pocket Costs –future outlay of financial resources as a consequence of a
decision.
F. Opportunity Costs – income or benefit sacrificed or foregone when an alternative is
selected over another.
G. Imputed Costs – assumed or hypothetical costs representing the cost or value of a
resource that is utilized for a specific purpose which do not involve actual outlay of
cash.
H. Sunk Costs – incurred costs that cannot be changed by any decision made now or in
the future.
I. Quality Costs – associated with conforming to standards.
J. Prevention Costs – costs incurred in support to activities whose purpose is to reduce
the number of defects.
K. Appraisal Costs – monitoring costs for some mistakes not eliminated through
prevention measures.
L. Failure Costs – maybe internal loss such as scrap or rework or an external loss such
as warranty cost or cost of recalling defective product.

VI. Costs in Relation to Persons Regulating Them

A. Controllable Costs – can be regulated by the management responsible for it.
B. Non-controllable Costs – cannot be regulated because these are imposed by the top
management or allocated among the departments.

VII. Costs in Relation to Timing of Cost Computation or Preparation

A. Historical Costs – costs determined after the event which are usually referred to as
actual costs.
B. Predetermined Costs – costs that are set up from the analyses and forecast made
before the event and represent not what has happened but rather what is expected
to happen.
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C. Budgeted Costs – estimated costs to be incurred in undertaking an activity or

project.
D. Standard Costs – predetermined costs per unit of finished product.

VIII. Costs in Relation to Timing of Charges against Revenues

A. Product Costs / Inventoriable Costs – costs that are attached to the product and
matched with revenue in the period in which the product is sold.
B. Period Costs – costs that are totally charged against current revenues as expenses
during the current period.
C. Capital Expenditure – relate to use of resources for future benefits which are
recorded as assets.
D. Revenue Expenditure – costs that will benefit only the current period and are
recorded under the expense account.

Cost accounting throughout the value chain

Managing costs in a business is an important component of the work done by
business owners and managers. It is a need to have a firm foundation on how the costs are
budgeted and expended to make good planning decisions.
Each of the processes in the value chain involves costs that need to be incorporated
into the price of the product or service. Each step in the value chain is important, each
works with the other, and managerial accounting ties them all together. If these things are
arranged into systems and activate systematically, it will become possible to produce
something for which customers are willing to pay a price. Porter argues that the ability to
perform particular activities and to manage the linkages between these activities is a source
of competitive advantage. The basic model of Porter’s Value is as follow:

Source: https://www.slideshare.net/sheetalgwagh/value-chain-analysis-using-porters-model
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The term, ‘Margin’ implies that organizations realize a profit margin that depends
on their ability to manage the linkages between all activities in the value chain. In other
words, the organization is able to deliver a product/service for which the customer is willing
to pay more than the sum of the costs of all activities in the value chain.

The value chain analysis describes the activities the organization performs and links
them to the organization competitive position. It reviews the processing steps that a
business follows to deliver goods and services. The intent is to locate those processing steps
at which value is added to the final product. In addition, the chain of activities is reviewed
to see where costs are being incurred. The ultimate goal of the analysis is to achieve the
highest possible value increase for customers while incurring the lowest possible cost. The
basic processing steps involved in value chain analysis are:

a. Inbound logistics, which involves sourcing the correct raw materials and
merchandise, and bringing them to the business in the most cost-effective manner.
Raw materials are important as to it mainly composes the business’s products. As
such the lower the cost of these raw materials are, the higher the room for profit
margin is. However, remember that your ultimate goal is to achieve the highest
possible value increase. Thus, your focus must not only be on the cost of the raw
material but also the quality of it. As Taguchi said, “Cost is more important than
quality but quality is the best way to reduce cost.”
b. Operations, which transform the raw materials into finished goods. Or, if the
company is a retailer, operations can refer to the positioning of acquired
merchandise within its stores. In this activity, the concern is on the conversion of
products. Whether the people involved in the production are efficient or not,
whether the overhead costs incurred are excessive due to inefficiencies that lead to
rework, or whether the arrangement of the equipment helps the speed of production
or is their need for rearrangement of equipment. These are some of the concerns in
operations which can be solved after proper cost analysis.
c. Outbound logistics, which focuses on warehousing and delivery of goods. In
outbound logistics, cost-effective strategies shall be implemented such as having a
warehouse within the production site in order to lessen expenses on transportation
of products. Producing products just in time for delivery to prevent incurring costs
on the storage of products. In terms of delivery, deliveries shall be made at once in
an area on a specific schedule to prevent high cost on deliveries.
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d. The marketing and sales function, marketing pertains to the advertising or

promotion of products. Whereas, sales function pertains to the pricing and the
distribution of the product. These functions increase the level of value of the product
by affecting the perception of the customers. Products which are well advertised are
perceived to be of higher value. Also, products on sale are perceived by customers
to be more worthy of their spending than those that are not. However, though this
may increase a business’s sale it may also increase its expenses or reduce its gross
sales which may lead to lesser margin. As such, there shall be proper balance of the
cost and its benefits.
e. The field servicing function, which can also be employed to increase and maintain
level of value after the acquisition of goods or services by customers. Remember
that your commitment to your customers is a continuing service. As such, when a
customer returns a food due to spoilage, you have the obligation to replace the
product. These are situations a business shall prevent to keep costs at minimum.

All other parts of a business, which consists the support activities, such as
accounting, administration, human resources, and information technology, are usually
considered to be cost centers, where the focus is solely on cost reduction. However, it is
possible to add value in some of these areas. For example, information technology can be
used to develop unique applications that give the business a competitive advantage.

With the help of cost accounting, once management understands where value and
costs are being generated in the organization, it can focus its attention on these areas.
Business owners would be able to determine whether in such activity lower costs or higher
performance is needed.

With that, you shall be able to explain how cost accounting information is used for
decision making and performance evaluation in organizations. As an application of your
learning, if you were to put up a business, how can you manage it in order to attain highest
possible profit margin. Use Porter’s value chain provided to determine what efficient
procedures are necessary on each activity.

You are to finish this activity and submit it together with the following assessment
activities.
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I. Multiple Choice: Read through each statement and encircle the letter that corresponds
to your answer.
1) Financial accounting provides a historical perspective, whereas management accounting
emphasizes:
A)the future C) a current perspective
B) past transactions D) reports to shareholders
2) Cost accounting provides all of the following EXCEPT:
A) information for management accounting and financial accounting
B) pricing information from marketing studies
C) financial information regarding the cost of acquiring resources
D) nonfinancial information regarding the cost of operational efficiencies

3) The approaches and activities of managers in short-run and long-run planning and
control decisions that increase value for customers and lower costs of products and
services are known as:
A) value chain management C) cost management
B) enterprise resource planning D) customer value management

4) Cost accounting:
A) provides information on the efficiency of factory labor
B) provides information on the cost of servicing commercial customers
C) provides information on the performance of an operating division
D) All of these answers are correct.
5) Place the four business functions in the order they appear along the value chain:
Customer service Design
Marketing Production
A) Customer Service, Design, Production, Marketing
B) Customer Service, Marketing, Production, Design
C) Design, Production, Marketing, Customer Service
D) Design, Customer Service, Production, Marketing
6) The value chain is the sequence of business functions in which:
A) value is deducted from the products or services of an organization
B) value is proportionately added to the products or services of an organization
C) products are evaluated with respect to their value to the supply chain
D) usefulness is added to the products or services of an organization
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7) ________ is the acquisition, coordination, and assembly of resources to produce a

product or deliver a service.
A) Research and development C) Production
B) Customer service D) Marketing

8) Which of the following statements concerning an organization's strategy is NOT true?

A) Strategy specifies how an organization matches its own capabilities with the
opportunities in the marketplace to accomplish its objectives.
B) Management accountants provide input to help managers formulate strategy.
C) A good strategy will always overcome poor implementation.
D) Businesses usually follow one of two broad strategies: offering a quality product at a
low price, or offering a unique product or service priced higher than the competition.

9) Which of the following statements about customer value is NOT true?

A) Customer value is shown in a corporation's balance sheet.
B) Creating value for customers is an important part of planning and
implementing strategy.
C) How our product delivers customer value should be determined as part of a
company's strategy formulation.
D) It is possible to simultaneously lower cost and increase customer value.
10) Strategy is formulated by answering all of the following EXCEPT:
A) Who are our most important customers?
B) Is industry demand growing or shrinking?
C) Will our external auditors certify our strategy?
D) How sensitive are purchasers to price, quality, and service?

II. Essay. Answer the questions with not more than 5 sentences.
1. Differentiate management accounting from cost accounting.
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2. Which is more useful to an operations manager, financial accounting or management

accounting? Why?
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References:
https://www.accountingnotes.net/cost-accounting/value-chain-analysis/value-chain-
analysis-with-diagram-cost-accounting/5852
https://accountinginfocus.com/managerial-accounting-2/introduction-managerial-
accounting-2/the-value-chain/